Donegal Group Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; compared with the three months ended March 31, 2019, and balance-sheet figures compared with December 31, 2019. Donegal writes property and casualty insurance through independent agents, primarily in Mid-Atlantic, Midwestern, New England and Southern states. Its segments are personal lines, commercial lines and investments. Atlantic States shares pooled underwriting results with Donegal Mutual under an 80%/20% arrangement.
Key financial results
| Metric | Q1 2020 | Q1 2019 / prior balance date |
|---|---|---|
| Net premiums earned | $187.3 million | $188.1 million |
| Net premiums written | $198.2 million | $199.9 million |
| Total revenues | $184.9 million | $214.7 million |
| Net investment income | $7.4 million | $7.0 million |
| Net investment gains (losses) | $(10.7) million | $18.1 million |
| Net income | $3.7 million | $23.0 million |
| EPS, Class A / Class B | $0.13 / $0.12 | $0.82 / $0.75 |
| Operating cash flow | $10.8 million | $11.5 million |
| Cash and short-term investments | $125.0 million | $63.3 million at Dec. 31, 2019 |
| Total assets | $2.023 billion | $1.923 billion at Dec. 31, 2019 |
| Stockholders’ equity | $459.6 million | $451.0 million at Dec. 31, 2019 |
| Borrowings under lines of credit | $85.0 million | $35.0 million at Dec. 31, 2019 |
Net income was affected by a $10.7 million investment loss, primarily unrealized losses on equity securities amid the sharp market decline. The 2019 comparison included a $12.7 million gain from the sale of Donegal Financial Services Corporation (DFSC). Q1 2020 income before tax was $2.5 million; a $1.2 million income tax benefit included a $1.6 million benefit related to carrying back 2018 net operating losses under the CARES Act.
Insurance underwriting improved: the GAAP combined ratio was 97.0%, versus 99.3% in Q1 2019; the statutory combined ratio was 95.4%, versus 97.1%. A ratio below 100% generally indicates underwriting profitability. The GAAP expense ratio rose to 33.4% from 32.6%, while lower loss and weather-related losses supported the improved combined ratio. Weather-related losses were $6.9 million, down from $9.7 million. Prior-year reserve development was favorable by $4.3 million, compared with $4.0 million a year earlier.
Changes versus the prior period
- Net premiums earned declined 0.4%; net premiums written fell 0.8%. Commercial lines written premiums increased 7.1%, while personal lines decreased 11.2%, reflecting underwriting actions and attrition.
- Net income fell to $3.7 million from $23.0 million, principally reflecting the swing from investment gains to losses and the absence of the prior-year DFSC sale gain.
- Investment income rose to $7.4 million from $7.0 million, attributed primarily to higher average invested assets; investment losses were $10.7 million versus gains of $18.1 million.
- Cash from operations was $10.8 million. Investing activities used $54.9 million, largely reflecting purchases of short-term investments; financing activities provided $47.1 million, including $50.0 million of new FHLB borrowing.
- Total liabilities increased to $1.564 billion from $1.472 billion at year-end, including higher unpaid losses, unearned premiums and borrowings. Equity increased to $459.6 million.
Liquidity, debt and capital
At March 31, Atlantic States had $85.0 million of fixed-rate advances from the Federal Home Loan Bank of Pittsburgh: $35.0 million at 1.74%, due August 2024, and $50.0 million at 0.83%, due March 2021. The $50.0 million advance was obtained as contingent liquidity amid COVID-19 uncertainty. Donegal had no borrowing outstanding on its separate M&T revolving credit line and could borrow up to $30.0 million; that facility expires in July 2020. The company also had $5.0 million of subordinated debentures carrying 5.00% interest.
Cash was $52.3 million and short-term investments were $72.7 million at quarter-end. The filing reports approximately $39.9 million of subsidiary dividends available for distribution to Donegal in 2020 without prior regulatory approval, subject to applicable restrictions. No material capital expenditure commitments were reported. On April 15, the board declared quarterly dividends of $0.15 per Class A share and $0.1325 per Class B share, payable May 15 to holders of record May 1.
Outlook, risks and unusual items
- The filing provides no specific earnings or premium guidance. Management cautions that first-quarter results are not necessarily indicative of full-year 2020 results.
- COVID-19 had disrupted economic activity in Donegal’s operating regions and contributed to equity-market declines and lower interest rates. The ultimate effects were uncertain. Risks include lower insurance demand and premium collections, changes in claims and litigation, mandated coverage or premium relief, market-value declines, and lower reinvestment income.
- Management obtained the $50.0 million FHLB advance as precautionary liquidity. Investment losses were primarily equity-market related; the company reported no investment impairment losses in Q1.
- Loss reserves are inherently uncertain. A 1% change in net loss and loss expense reserves would affect pretax results by approximately $5.2 million. Management reported increasing average claim severity and slower settlement of litigated claims, while stating that reserves were considered adequate.
- Management identified risks involving weather, reinsurance availability and cost, interest rates, competition, technology systems, regulation, litigation and the adequacy of loss reserves. It reported no material change in market-risk exposure other than interest-rate and pricing fluctuations related to COVID-19.
- There were no legal proceedings reported, and management concluded disclosure controls were effective as of March 31, 2020.
Important facts for investors to verify
- Whether COVID-19-related changes in demand, premium collections, claims, coverage disputes and regulatory actions materially affect results after quarter-end.
- Whether equity-market volatility and lower reinvestment rates continue to affect investment values, investment income and capital.
- The repayment or refinancing plan for the $50.0 million FHLB advance due March 2021 and the status of the M&T credit facility expiring July 2020.
- Whether the favorable reserve development and combined-ratio improvement persist, particularly given commercial auto underwriting losses and the sensitivity of reserves to estimation changes.
- The durability of premium trends, including commercial-line growth and continued contraction in personal lines, and the effect of underwriting and pricing actions on profitability.